Lecture # 03

1.1

Introduction

Forward Price

1.2

The forward price for a contract is the delivery price that would be applicable to the contract if were negotiated today (i.e., it is the delivery price that would make the contract worth exactly zero)

The forward price may be different for contracts of different maturities

Terminology

1.3

The party that has agreed to buy has what is termed a long position

The party that has agreed to sell has what is termed a short position

Futures Contracts (page 6)

1.4

Agreement to buy or sell an asset for a certain price at a certain time

Similar to forward contractWhereas a forward contract is traded OTC,

a futures contract is traded on an exchange

Exchanges Trading Futures

1.5

Chicago Board of TradeChicago Mercantile ExchangeLIFFE (London)Eurex (Europe)BM&F (Sao Paulo, Brazil)TIFFE (Tokyo)and many more (see list at end of book)

The Forward Price of Gold

1.6

If the spot price of gold is S and the forward price for a contract deliverable in T years is F, then

F = S (1+r )T

where r is the 1-year (domestic currency) risk-free rate of interest.In our examples, S = 300, T = 1, and r =0.05 so that

F = 300(1+0.05) = 315

Options

1.7

A call option is an option to buy a certain asset by a certain date for a certain price (the strike price)

A put option is an option to sell a certain asset by a certain date for a certain price (the strike price)

American vs European Options

1.8

An American option can be exercised at any time during its life

A European option can be exercised only at maturity

Intel Option Prices (May 29, 2003; Stock Price=20.83); See Table 1.2 page 7

Strike Price

June Call

July Call

Oct Call

June Put

July Put

Oct Put

20.00 1.25 1.60 2.40 0.45 0.85 1.50

22.50 0.20 0.45 1.15 1.85 2.20 2.85

1.9

Exchanges Trading Options

1.10

Chicago Board Options ExchangeAmerican Stock ExchangePhiladelphia Stock ExchangePacific ExchangeLIFFE (London)Eurex (Europe)and many more (see list at end of book)

Options vs Futures/Forwards

1.11

A futures/forward contract gives the holder the obligation to buy or sell at a certain price

An option gives the holder the right to buy or sell at a certain price

Types of Traders

1.12

• Hedgers

• Speculators

• Arbitrageurs

Some of the largest trading losses in derivatives have occurred because individuals who had a mandate to be hedgers or arbitrageurs switched to being speculators (See for example Barings Bank, Business Snapshot 1.2, page 15)

References

1.13

Adopted from Options, Futures, and Other Derivatives, 6th Edition, Copyright © John C. Hull 2005